What has driven up oil prices

Speculation and a falling dollar may now be as important as supply and demand, analysts say.

By Peter Grier | Staff writer of The Christian Science Monitor

from the May 2, 2008 edition

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Washington - The recipe for record US gasoline prices goes like this: Take a tight oil supply and growing world demand. Add a falling dollar and lots of investment money flowing into oil and other commodities.

Finish with market turbulence caused by the annual switch from winter to summer gasoline blends. The result: an average US retail price for regular of more than $3.60 a gallon.

Will gasoline stay that high? At least through the summer, say experts. At the margin, pump prices may now depend on currency fluctuations and financial speculators as much as on traditional economics.

"The old fundamentals – the balance between demand and supply – still matter, but it is these new factors that are the driving force behind the record high," concludes a recent analysis by Cambridge Energy Research Associates.

On international markets, the price of a benchmark barrel of oil has retreated a bit in recent days. But the recent state of the market can be seen in the fact that on May 1 Exxon Mobil Corp. reported first quarter net income of $10.89 billion – its highest ever.

Average US retail gas prices have risen for five weeks in a row, according to the Energy Information Administration's latest available figures. At $3.60 per gallon, the average price of a gallon of regular has now spiked 21.4 cents since April 14.

Looking back a bit further, gas prices have climbed over $1.40 a gallon in 18 months. Sure, China and India are getting richer and their citizens are using more petroleum. But has everyone in Guangzhou purchased a Cadillac Escalade since, say, March?

"The market has gone [so high] for a variety of reasons, some of which are fundamental, and some of which are speculative," says Amy Myers Jaffe, a fellow in energy studies at the James A. Baker III Institute for Public Policy at Rice University.

Perhaps the most fundamental of the fundamentals is supply – specifically, a flattening in the growth of available oil reserves.

Throughout the 1980s and 1990s, increases in demand for petroleum products were quickly counterbalanced by the appearance of new sources of supply, say experts.

That pace since has slowed. New fields are still being discovered, in Brazil and other places around the globe, but it takes a long time to make them operational. Meanwhile, the end of the era of cheap and easy oil extraction may be coming.

"Since 2000, we have hit a more mature period in terms of supply. At the same time, we've had the demand shock come into play," says David Pumphrey, deputy director of the energy and national security program at the Center for Strategic and International Studies.

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